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Troy’s Sebastian Lyon: Why investors’ options are “cruelly limited”

11 May 2017

The FE Alpha Manager, who heads up the £3.9bn Trojan fund, explains why most investors are forced into acting bullishly despite maintaining a cautious outlook.

By Lauren Mason,

Senior reporter, FE Trustnet

Defensive positioning and the ability to look through positive market moves is required in today’s investment climate, according to Sebastian Lyon (pictured), who warns that the elongated bull market is at odds with investor sentiment.

The FE Alpha Manager, who heads up the £3.9bn Troy Trojan fund, says a lack of options for investors has forced them into risk assets and thereby has caused a reluctant market bubble.

While the backdrop is very different from the cusp of the tech bubble in 2000, he says valuations could consequently mean revert with a “prolonged whimper” as opposed to a “sudden bang”.

“The current and prolonged bull market continues to climb the wall of worry in stark contrast to the investor euphoria that was observable in the lead up to these two stock market peaks,” Lyon explained.

“Elevator melodies rather than heavy metal is today’s market mood music. Most investors I meet and talk to are not thinking bullishly, but they are acting bullishly.”

 Since last June’s EU referendum, the global-facing FTSE 100 index has rallied which, according to many, has been caused by weak sterling as opposed to positive investor sentiment.

At the same time, fears surrounding geopolitical uncertainty and historically low interest rates have forced investors into fixed income assets in a bid for income, which has pushed bond yields down to all-time lows.

Performance of indices since the EU referendum

 

Source: FE Analytics

Lyon says this disappearance of income from traditionally ‘safe’ assets has caused a relay race-style bid for yield, whereby investors have had to “change to the outside lane” towards higher-risk investments to achieve the desired outcome.

“American distressed debt investor Howard Marks thus describes investors as ‘handcuffed volunteers’, their investment options are cruelly limited,” the manager said. 


“Given the psychological backdrop the market certainly doesn’t ‘feel’ like a bubble, but traditional measures of valuation insist that equities led by US indices, are expensive by historical standards.”

For instance, he points out the cyclically-adjusted price-earnings (CAPE) ratio of the US stock market is currently at 29.4 times compared to its long-term average of 16.8 times, which is a level that has only been reached during the 1920s before the Great Depression and during the dotcom bubble of 2000.

“The US equity market valuation as measured by the CAPE multiple and the Q ratio (the difference between an asset’s accorded market value and its replacement value) have been admittedly high for some years,” Lyon continued.

“Yet other metrics also point towards equities being expensive. US market capitalisation measured against GDP, for instance, also confirms that stocks are challenging their 2000 valuation high.”

 

Source: FE Analytics

The manager points out that economic forecaster GMO estimates a loss of value of 3.8 per cent for US stocks for the next seven years, which is significantly greater than its predicted losses of 2 per cent during the summer of 2007.

Lyon says this alone presents a compelling reason to remain defensively positioned, given the accuracy of the firm’s forecasts in the past.

“Markets, admittedly, remain bathed in sunshine and blue skies make it very difficult to consider the threats of changes to the weather,” he said.

“Professional investors under the age of 30 have likely never experienced the storm of a testing correction or indeed a bear market. They have enjoyed only tailwinds blown from central bank-sponsored asset inflation.”

Given lacklustre returns from asset classes across the board – fixed income and cash in particular – the manager says the merits of investing in equities at the moment are clear.


However, he says that catalysts for market corrections in the past have been evident for those prepared to actively seek them.

“In 2007 the debt edifice was ripe for collapse and the early warnings were visible in the form of Collateralised Debt Obligation funds liquidating and Northern Rock customers queueing for their savings back,” Lyon reasoned.

“These were signs on the road to the failure of Bear Stearns and Lehman Brothers. Previous market highs were less obvious – rising interest rates usually called time on elevated and rising valuations.

“With the Federal Reserve now raising rates for the first time in over a decade the clock is ticking.”

While the markets during 1929 and 2000 reached monumentally high levels, the manager warns that the exuberance of these “once in a lifetime peaks” is not the only way indices can arrive at the cusp of a correction.

“In 2007 markets topped out without a high degree of retail investor activity,” he argued. “If and when US valuations revert to the mean they could do so with a prolonged whimper as much as with a sudden bang.”

 

Since Lyon launched Troy Trojan in 2001, it has returned 228.16 per cent compared to the FTSE All Share’s return of 148.85. It has done so with a maximum drawdown (which measures the most money lost if bought and sold at the worst possible times) of 9.81 per cent compared to its benchmark’s drawdown of 41.09 per cent.

Performance of fund vs benchmark since launch

 

Source: FE Analytics

The fund has a clean ongoing charges figure of 1.05 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.